9911796707
TMI Blog2014 (2) TMI 1070X X X X Extracts X X X X X X X X Extracts X X X X ..... y of Indigene Pharmaceuticals Inc. USA. The business activity of the assessee is in research & development works in the fields of chemicals, agrochemicals, bulk drugs etc. For the assessment year under dispute i.e. for 2007-08, the assessee filed its return of income on 26-102007 declaring a loss of Rs.14,08,78,326/-. In course of scrutiny assessment proceedings, the Assessing Officer noticing that the assessee has entered into international transaction with its AE by reimbursing an amount of Rs.8,33,45,495/- towards cost of R & D work, made a reference to the TPO, Hyderabad for determining the ALP of the transaction. During the proceedings before the TPO, he noted that as per the TP report, the assessee is a rapidly growing bio-pharmaceuticals and research oriented company engaged in the activity of developing, manufacturing and marketing of molecular combination based healthcare products for global prescription (Rx) and Consumer Health Care (CHC) markets having its research and development ( R & D) operations in Hyderabad. As per the financials for the previous year 2006-07, the operating revenue was admitted at nil and operating expenses at Rs.14,30,83,391/- which resulted in a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... A does not carry out any advance marketing function for marketing the products to be launched after completion of the project. For carrying out the R & D support activities, Indigene USA claims reimbursement from Indigene India in respect of actual cost incurred by it. Out of the R & D activities specified by Indigene India, Indigene USA outsourced some of the activities to independent consultants, institutions and companies. The TP study further stated that the entire fixed assets for R & D activities for the project are employed by the Indigene India. So far as Indigene USA is concerned, since it carries R & D activities as per the specifications of Indigene India, no specific assets are being used exclusively for carrying out R & D activities for the project. Indigene USA uses its assets which are already been employed for the purpose of its own business on need basis. It is also clear from the TP study that indigene India assumes all risks including market risk, financial risks and all other risks. In the TP study the assessee has chosen itself as tested party for transfer pricing analysis because segregation of project cost and net operating assets of Indigene USA that are att ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l of the total outstanding loan immediately. Clause 2.8 of the agreement specified that Industrial Partner i.e., assessee shall utilise the loan only for the purpose of the project and not for any other purpose including civil constructions and renovation of the R & D and associated facilities. Diversion of funds to other purposes will entail cancellation of the loan and immediate repayment of the outstanding loan amount with a penal interest @ 12% compounded monthly. Clause-3 of the agreement stipulates that Indigene India must have an R & D centre which has valid recognition of Department of Scientific and Industrial Research (DSIR), Government of India, if not registered; the firm will undertake to get the R & D centre so recognised within 12 months. The TPO observed that the assessee has outsourced certain R & D activities to its parent company Indigene USA and for carrying out such R & D activities, the AE has raised debit notes, altogether 12 in number, amounting to USD 18,44,154, which on the basis of application of CUP was found by the assessee to be within arm's length. The TPO however rejected TP study submitted by the assessee by treating it to be unreliable due to the f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 06- 07, R & D to the tune of Rs.8,33,45,495/- out of total operating expenses of Rs.12,59,21,902 has been claimed to have been outsourced. On considering the above fact, the TPO noted that DST has advanced soft loan to Indigene India to promote research activities within the country, in order to provide skilled employment and to boost the country's R & D capabilities. Therefore, what is the cost advantage, Indigene India gets by outsourcing R & D work to its parent Indigene USA, when it claims that it has a well established facility in the country that is, at ICICI knowledge Park, Hyderabad is not established by way of any analysis. The economic reason for outsourcing any business activity is that of lower cost in the chosen location particularly on account of manpower costs and generally the work is outsourced from developed countries to developing countries such as countries like US and UK to countries like India. He further noted that the assessee could not demonstrate that the R & D work which is outsourced to its AE cannot be undertaken in India, if not, at what cost the said work could have been done. He further noted that when both the parent, Indigene USA and the subsidiary ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for carrying out the research activities or it can also outsource some of the activities to other consultants, institutions, and companies. However, the basis of pricing of the so called outsourced work is not spelt out in the agreement. The agreement do not indicate/mention as to which is the dedicated laboratory in which the R & D work outsourced by Indigene India is undertaken and who are the people designated to undertake the said work. The TPO therefore opined that in absence of any such documentation and verifiable information the uniqueness of the R & D work outsourced remains unexplained as the R & D work carried out is one and the same. The TPO further noted that the agreement between the assessee and its AE is silent on the issue of sharing of intellectual property rights such as patents, know-how, drug master files, dossiers, its valuation, pricing etc. Although the assessee submits that it is difficult to estimate the commercial value of the final products, but there is no documentation to verify as who has the rights over the new drug products and their marketing in India and abroad. There is no documentation available so as to verify whether any filings have been made ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e available with the assessee with reference to the services actually carried out and delivered. He noted that the assessee has failed to explain as to what are the benefits that are going to accrue out of such payment. Therefore, he inferred that the funds given to its AE assumes the character of loan and not expenditure. He further inferred that what are the R & D activities carried out by its AE for its own purpose and what are the activities carried out for the purposes of the assessee abroad remained unsubstantiated and if at all any R & D work was carried out it can only for the benefit of the AE and not the assessee. The TPO held that the entire outsourcing of R & D work by the assessee to its AE is a sham transaction and in reality the assessee has diverted the loan obtained from DST to its AE for purposes other than business and proceeded to determine the ALP as under:- 1) ALP payment made in the form of reimbursement to AE Nil 2) Price paid Rs.8,33,45,495 3) Excess paid being adjusted u/s 92CA Rs.8,33,45,495 After proposing such adjustment, the TPO further observed that since the funds advanced to the AE is in the nature of loan, the assessee is liable to charge inter ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Nil. The DRP after considering the submissions of the assessee negated all the contentions. The DRP endorsed the view of the TPO that the assessee was required to have R & D centre with the recognition of DSIR and soft loan of Rs.17 crores were disbursed by the DST to promote research activities in the country in order to provide a boost to R & D capability. 14. The DRP also endorsed the view of the TPO that when the global companies were on Indian territories in the field of drugs and pharmaceuticals, there is no reason why the assessee should outsource the research and development activities to the AE. Further, the DRP also noted that, as observed by the TPO, the documentation entered into between Indigene USA and third parties have not been furnished before the TPO. So far as the assessee's contention that the DST and DPRP had endorsed the outsourcing of R & D work, the DRP observed that what the DST and expert committee of DPRP had desired was conducting of R & D project in accredited and compliant laboratory under the US-FDA and European guidelines, but it never endorsed the outsourcing of R & D work to overseas laboratory. The DRP further observed that the there is no evide ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... The learned AR submitted that in the year 2003 to 2006, R & D work relating to Phase-A of the Project was carried out. The appellant has submitted all the documents in connection with R&D expenses incurred like proposal to DST for phase B portion of the project, loan agreement, minutes of expert committee meetings, summary of project progress reports etc before the Ld TPO during the course of hearing. It was submitted, as part of assessee's global development and regulatory registration plan the joint expert team consisting of officials of the Drugs & Pharmaceuticals Research Programme (DPRP) and the appellant had decided that all development work was to be conducted in India and abroad. This was done to ensure that all the development work and corresponding results are in compliance with international drug development and registration standards. This was very important to ultimately seek the approvals from the Drug Controller General of India and US FDA in the US, EMEA in Europe where the regulatory hurdles are very stringent. It was to ensure that development work is done only in accredited laboratories and testing facilities. The joint team identified that the new drug candidat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ect Indigene India had outsourced selected studies of the project to Indigene USA. It is also to be kept in mind that the proposal submitted by the assessee to Department of Science and Technology for securing the loan clearly specifies that all CGMP, GLP, GCP work / will be conducted in the accredited facilities under US FDA guidelines. 16. It was submitted, the actual cost of R&D work associated with Phase B has been conducted either in house in India or outsourced to third parties by Indigene USA. The third parties in USA have billed to Indigene USA and Indigene USA in turn has billed Indigene India on cost-to-cost basis. There is no profit mark up and as of date no revenues are generated from this project. It was submitted that only after successful development of any Rx Drug from this project and after the developed product receives regulatory approval from the appropriate regulatory authorities for marketing of the product, then only it is possible to commercialise the product and result in revenue generation. Learned AR submitted, the agreement by and between Indigene (India) and Indigene (USA) clearly indicates that any revenues generated from the project would be shared o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e has bought into the business as the same cannot be quantified. Hence, the legitimacy of expenditure cannot be questioned. In support of such contention, the learned AR relied upon the following decisions:- i) Mumbai ITAT in the case of Dresser-Rand India (P) Ltd Vs Addl.CIT (2011) 47 SOT 423 (Mum) ii) Delhi High Court in the case of CIT Vs EKL Appliances (ITA No's 1068/2011 & 1070/2011) iii) Hyderabad Bench in case of Social Media India Ltd. Vs. ACIT (ITA No.1711/Hyd/2012 dated 4-10-2013. 17. The learned DR strongly supporting the reasoning of the TPO submitted that agreement between the assessee with its AE is of general nature. There is no condition in the agreement with regard to the rights of the parties so far as confidentiality is concerned. Both the assessee and the AE are engaged in same activity. Hence, there is no reason to outsource the work to AE, more so when AE itself is not doing itself but is getting it done by further outsourcing. He submitted that, the DST of Govt. Of India has given unsecured loan of Rs.17 crores at a very low rate of interest which was diverted by the assessee to its AE apparently without any business purpose and solely for the benefit of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... re (CHC) markets. On perusal of the order of the TPO as well as DRP, it becomes abundantly clear that they have refused to accept the transaction as genuine on the following reasons:- I) The assessee has not shown the reasons why it had returned back the share application money of Rs.8,70,20,000 and advance of USD 450000 to its AE. Whereas it has taken loan of Rs.17 crores from DST out of which an amount of Rs.8,33,45,495/- paid to the AE towards reimbursement of expenses. II) The assessee has not substantiated what is the cost advantage in outsourcing the work to the AE when it is claimed that it is well established facility at Hyderabad for undertaking such activities. III) The assessee could not demonstrate that the R & D work outsourced to its AE cannot be undertaken in India. IV) The assessee has not supplied documents entered into between Indigene USA and third parties with regard to the outsourcing of work by Indigene USA to third parties. V) There is documentation available which could show that the work outsourced is like useful and identifiable with reference e to the research work mandated by the DST of Government of India. VI) The basis of pricing of outsourcing h ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e research and development work cannot be outsourced to an outside country. Only thing it says is, the assessee must have arranged the facility with the regulatory standard to undertake such R & D income. It is the contention of the assessee that the entire R & D work was not outsourced but only a portion of work i.e. relating to Respiratory disorders has been outsourced to the AE as no facilities are available which comply to the standard of US and European Regulatory Authority in India. In this context, it is to be noted that the TPO as well as the DRP have held that outsourcing of research and development work was in violation of the agreement entered into with the DST. 21. It is not disputed that the entire project of R & D was under the aegis of DST. It is also a fact that the DST and the monitoring committee review the progress of the project undertaken by the assessee at regular intervals. This is very much evident from the minutes of meeting of the monitoring committee and progress report which are placed in the paper book. On a perusal of the minutes of midyear monitoring committee meetings of the project, held on 18- 11-2006 and 8-8-2007, copies of which are at pages 130 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Addl. CIT (supra) has held as under:- ""We find that the basic reason of the Transfer Pricing Officer's determination of ALP of the services received under cost contribution arrangement as 'NIL' is his perception that the assessee did not need these services at all, as the assessee had sufficient experts of his own who were competent enough to do this work. For example, the Transfer Pricing Officer had pointed out that the assessee has qualified accounting staff which could have handled the audit work and in any case the assessee has paid audit fees to external firm. Similarly, the Transfer Pricing Officer was of the view that the assessee had management experts on its rolls, and, therefore, global business oversight services were not needed. It is difficult to understand, much less approve, this line of reasoning. It is only elementary that how an assessee conducts his business is entirely his prerogative and it is not for the revenue authorities to decide what is necessary for an assessee and what is not. An assessee may have any number of qualified accountants and management experts on his rolls, and yet he may decide to engage services of outside experts for auditing and mana ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Supreme Court that "there are usually many ways in which a given thing can be brought about in business circles but it is not for the Court to decide which of them should have been employed when the Court is deciding a question under Section 12(2) of the Income Tax Act". It was further held in this case that" it is not necessary to show that the expenditure was a profitable one or that in fact any profit was earned". In CIT v. Walchand & Co. etc., (1967) 65 ITR 381, it was held by the Supreme Court that in applying the test of commercial expediency for determining whether the expenditure was wholly and exclusively laid out for the purpose of business, reasonableness of the expenditure has to be judged from the point of view of the businessman and not of the Revenue. It was further observed that the rule that expenditure can only be justified if there is corresponding increase in the profits was erroneous. It has been classically observed by Lord Thankerton in Hughes v. Bank of New Zealand, (1938) 6 ITR 636 that "expenditure in the course of the trade which is un-remunerative is none the less a proper deduction if wholly and exclusively made for the purposes of trade. It does not r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (a) does not authorize disallowance of any expenditure on the ground that it was not necessary or prudent for the assessee to have incurred the same or that in the view of the Revenue the expenditure was un-remunerative or that in view of the continued losses suffered by the assessee in his business, he could have fared better had he not incurred such expenditure. These are irrelevant considerations for the purpose of Rule l0B. Whether or not to enter into the transaction is for the assessee to decide. The quantum of expenditure can no doubt be examined by the TPO as per law but in judging the allowability thereof as business expenditure, he has no authority to disallow the entire expenditure or a part thereof on the ground that the assessee has suffered continuous losses. The financial health of assessee can never be a criterion to judge allowability of an expense; there is certainly no authority for that. What the TPO has done in the present case is to hold that the assessee ought not to have entered into the agreement to pay royalty/ brand fee, because it has been suffering losses continuously. So long as the expenditure or payment has been demonstrated to have been incurred or ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... then it is for the department to bring on record material to show that such facilities are available in India and what would be cost of research and development work with regard to this particular research work. In the aforesaid circumstances, we are of the view that without bringing sufficient evidence on record to prove that the transaction between the assessee and its AE is not genuine, the conclusion arrived at by the TPO/DRP that it is a sham transaction, cannot be accepted. Of course, it needs to be mentioned that TPO as well as DRP have noted that the assessee neither produced any documentation or any other evidence to substantiate its claim that reimbursement of expenditure to AE is within arm's length. In that case, TPO has ample power to call upon the assessee to produce necessary documents or he can himself obtain information by means of necessary enquiry. If the assessee fails to justify the CUP applied by it then it is open for the TPO to adopt any other method as provided under the statute to find out the arm's length price of the expenditure incurred. However, it is the contention of the assessee that the invoices between the AE and other third parties in USA/Canada ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e scientific research expenditure incurred in India amounting to Rs.4,25,76,407" 26. Briefly the facts are, during the scrutiny assessment proceedings, the Assessing Officer noticed that the assessee had claimed deduction of Rs.12,59,29,902/- under the head 'scientific research expenditure' u/s 35(1) (i). When the assessee was asked to justify the deduction claimed by the Assessing Officer the assessee submitted that it has been incorporated mainly to carry on research and development work in the fields of chemical, agrochemical bulk, drugs, pharmaceuticals and biological products. It was submitted that the company has focussed on discovery, developing and delivering molecular combination base, health care product (multiceutics) for global prescription (RX) and consumer health care (chc) markets. It was submitted that during the previous year the assessee has carried out research and development activity only. It was stated that the project is not only unique but also rare as no other Indian Pharmaceutical company has yet developed and commercialised a new innovative drug for global market particularly to meet the regulatory requirements of USFDA and European (EMEA) Authorities. A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ld produce the certificate from the prescribed authority i.e. DGIT(E) in concurrence of Secretary, department of Science and Technology. The DRP further observed that even with regard to capital expenditure for in-house research conducted, the precommencement period expenses is to be allowed as per explanation to section 35(2)(i)(a). The DRP observed that as per the assessee's own admission, business receipts are yet to flow in hence the expenditure relates to the pre commencement period. The DRP observed that to the extent that the business has not commenced i.e., the commercialisation of the product has not been commenced. The pre-commencement expenditure revenue expenditure is governed by the provisions of section 35(1) and in so far as the conditions laid down therein are not fulfilled the entire expenditure of Rs.12.59 crores cannot be allowed as deduction. The fact that the commercialisation of the product has not commenced is evident from the cost contribution arrangement (CCA) submitted by the assessee. 28. The DRP finally concluded that the pre-commencement expenditure on R & D relating to the first three years, to the extent certified by the prescribed authority is to be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 8). The learned AR further submitted that in the subsequent assessment year i.e., Asstt. Year 2008-09 though the assessee has claimed similar deduction of expenditure, the Assessing Officer has allowed the expenditure incurred in India. With regard to the observation of the DRP regarding the approval of DSIR, the learned AR submitted that the same is required in the case of weighted deduction. 30. The learned departmental representative, on the other hand, supported the orders of the Assessing Officer and the DRP. 31. We have heard the submissions of the parties and perused the material on record. On a perusal of the orders of the Assessing Officer and DRP, it is to be noted that while the Assessing Officer has disallowed the deduction claimed by holding that it does not relate to the business of the assessee, the DRP has sustained the disallowance by observing that the expenditure relates to precommencement period of business. However, it is the specific contention of the assessee that there is no dispute to the fact it has commenced its business. It is further contention of the assessee that not generating income does not mean that the assessee has not commenced its business. A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tablished. The DRP therefore opined that the funds that are passed on to the AE is for other than business purposes. Once the funds are paid for non business purposes, interest expenditure is to be disallowed corresponding to the funds diverted. Accordingly, the DRP directed to disallow 3% of Rs.8,33,45,496/- being interest payable to DST. 35. After considering the submissions of the parties, we are of the view that the disallowance made cannot be sustained. Since we have already held that the transaction between the assessee and its AE relating to outsourcing of research and development activity cannot be held to be a sham transaction or diversion of funds, as a natural corollary, it cannot be held that the amount advanced to the AE is for non business purposes. We therefore direct the Assessing Officer to delete the addition of Rs.25,00,003/-. 36. Ground No.9 reads as under:- "The ACIT was legally erroneous in observing that interest income of Rs.33,87,799/- is not business income since the business of the assessee had not commenced and the same is to be treated as income from other sources" As can be seen from the impugned assessment order the Assessing Officer treated the in ..... X X X X Extracts X X X X X X X X Extracts X X X X
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